Fed: Markets have come to accept the likelihood of a December hike - BBH

In view of analysts at BBH, over the past few weeks, the markets have come to accept the likelihood of a December Fed hike.  

Key Quotes

“US interest rates have adjusted.  The pricing of December Fed funds futures contract is consistent with around an 80% chance of a hike.  The two-year yield is trading at the upper end of what is expected to be the Fed funds target range at the end of the year, after slipping below the current range a month ago.  The Dollar Index formed a bottoming pattern.”  

“Paradoxically, therein lies the challenge.  The anticipation of a hike is now well priced in, and the question is, what now?  The Dollar Index has met the initial technical target.  The 10-year yield has moved into the upper end of its six-month range.”  

“Where will the fuel come from for the next leg up for the dollar?  One important source may come from a reassessment of US monetary policy.  The critics complain that the Fed had anticipated a more aggressive pace of tightening than it delivered.  But this old news.  It is the echo of a cry from 2015 and 2016.  The Fed will likely deliver three hikes this year as it had indicated, and the market had doubted.  The issue is 2018.”  

“With a Fed funds target range of 1.00% to 1.25%, the effective average rate is steady at 1.16%.  The anticipated hike in December will likely lift the effective average to 1.41%.  That means that a hike in 2018 would lift the effective average to 1.66%.  The implied yield of the December 2018 Fed funds contract is 1.64%, suggesting the market remains profoundly skeptical of the three hikes that most Fed officials see as likely to be appropriate next year.”  

“We fully accept that the September employment data was distorted by the storms.  There is no reason to doubt that the underlying strength and improvement of the labor markets has ended.  Nor do we think it has accelerated.  While the headline was distorted to the downside by the most amount of people unable to go to work due to the weather in 20 years, the hourly earnings were flattered.”  

“Workers in food and drinking establishments, mostly lower pay, were particularly hard hit by the storm.  At the same time, there appears to have been an increased demand for some higher-paid professionals.  However, we can be confident that the upward revision to the August hourly earnings to 2.7% from 2.5%, was not skewed.  This is the strongest pace since 2009.”